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Vol. 4, Issue 6, Part I June 2003. What do Franchisees Really Want? Part 1 A successful business is the short and obvious answer to “What do Franchisees Want?” In this issue of FranchiseHelp OnLine Newsletter, we talk to franchise owners about their expectations of success in franchising and what role the Franchisee and the Franchisor play in fulfilling these expectations. Part 1 is a case study of unrealized expectations. We talk to a franchise owner who invested his life savings in a casual restaurant that continues to be a financial drain. This case study does not represent the typical franchise situation, but it is a true story that describes the risk element of franchising and illustrates how several mistakes can lead to a very bad outcome. Picking a Winning Franchise Concept Who do you blame when your entrepreneurial franchise dreams turn into a business and personal nightmare? The subject of our case study operates a casual restaurant on the weekend but continues to hold down a well-paying job to support his family and the cash shortfall of his franchise business. He primarily blames himself for his plight and holds no animosity towards his franchisor. He tells his story so prospective franchisees understand the risk side of franchising and can learn from his plight. The story begins with a 50-year-old senior executive facing corporate downsizing. With children in college, retirement was not an option. After years of marching to the tune of a corporation and having a modest financial nest egg, owning and operating a franchise seemed like a logical move. The strategy was to invest hard-earned savings into the concept and rely on his years of management experience to operate and grow the business. With experience in a related industry, a restaurant franchise seemed like a good fit. Researching the Concept After researching numerous franchise opportunities, a decision was made to go with a casual restaurant concept in operation for eight years but just starting to franchise. The performance of the company-operated locations disclosed in Item 19 of the Uniform Franchise Offering Circular (UFOC) was good and the concept was effectively expanding in its core market area. Unfortunately, there were no existing franchise operators to discuss the franchisor’s training program, marketing and operations support. The concept seemed unique, fairly easy to operate, and had strong customer appeal. Our new franchisee was optimistic about aggressive growth and a development agreement for two locations was inked. To complicate matters, the franchisee was laid off, but then accepted a full time position with another company. Operating the franchise quickly turned into getting an operating partner until the franchise revenue overproduced the new day job. The operating partner had no restaurant experience and no cash to put in the business but was a trusted business associate for many years. The operating partner completed an extensive franchise training program, which included in-store operations experience. Because of the time constraints of a new job, the franchisee was not able to participate in training and learn the intricacies of the business and how to solve store level problems. Building a Brand in Virgin Territory The initial challenge of the franchise owner was to find a high traffic location in his market area where his restaurant could grow revenue and build brand loyalty quickly. The franchisor’s site selection criteria required demographic and traffic studies. After completing the required research, a decision was made to go into a location that had some of the demographic attribute needed and 8,000 cars passing by daily. The franchisee reports, “Even though we agreed that it was not an ideal location, we could get a heck of a deal on the rent and we wouldn’t have to do quite the sales numbers to make a go of it.” The location was expected to have good long-term potential but did not have the best visibility from the street. In retrospect, selecting a less than ideal location, which was approved by the franchisor, was indicative of the growing pains of a new franchisor. “The franchisor has been through three marketing Vice Presidents and three real estate companies in the one year I have been associated with them,” states the franchise owner. High Expectations Turn to Cash Crunch High volume expectations quickly turned into operational shortcomings and red ink. Cash problems started from opening day with store revenue coming in at about 50% of projections. “The first six months were a disaster. Food costs were out of line, labor costs were out of line, and sales were nowhere near expectations. My partner became more and more frustrated,” reports the franchise owner. Increasing the advertising budgets to 8% of sales, significantly higher than the mandatory 3%, proved only moderately successful in boosting store sales. The franchisee was able to get a rent reduction after threatening to close the failing business. Because of the franchisee’s commitment to a full time position, he was only able to do grass roots and guerilla marketing efforts on the weekends. The franchisor’s support focused on operations and did little to introduce the concept to a new market area. Due to the trials and tribulations of the failing business, the operating partner exited after six months and a new operations manager was hired. With the franchisee directing the restaurant operation on the weekend and taking a more active role in cost containment efforts, the cash drain has slowed and the restaurant is getting closer to breakeven. Lessons Learned A tired and disillusioned franchisee now realizes the downside to franchising a business and considers what different steps should have been taken. Admittedly, the franchisee made many mistakes from the outset. The original plan called for a business savvy executive with adequate capital to be the owner/operator of a franchise operation. The Adding a marginal site for the first franchise location into the equation spelled disaster. The franchise owner reports the more obvious lessons learned include: 1) Don’t bet the ranch - As a first time small business owner, the franchise selection should have been a concept with a smaller investment and more in line with his financial situation. 2) Location is everything – With no brand awareness in the market, location is paramount. Getting a deal on a marginal location is only a deal for the landlord. 3) Experience in the business is key relevant experience - The person responsible for the day-today operations should have 4) Set realistic goals 5) Interpret the data instead of extrapolate the data - Item 19 earning claims disclosures in the UFOC are not always clear indications of how your unit will perform. Other considerations that you must factor into the equation are brand awareness in your market place, how long the units have been in operation, and quality of The franchisor has some flexibility on how to state the numbers in Item 19 disclosures. You can be sure the disclosure will have the most positive slant. The lessons learned for this franchise owner were difficult and expensive. “Everybody has a dream to be in business for themselves. The other side of it is, you can lose everything you have,” notes the franchise owner. Franchising provides tremendous opportunities for most investors but only if all aspects of the franchise decision are thoroughly investigated. Vol. 4, Issue 6, Part II June 2003. What Do Franchisees Really Want? Part II In this issue of FranchiseHelp OnLine Newsletter, we talked to Robert Purvin, Chair, Board of Trustees of the American Association of Franchisees & Dealers (AAFD). Purvin has a wide reaching understanding of the goals and aspirations of franchisees and the risk/reward relationship of franchising. Many of the concerns of franchisees were the impetus for the formation of the AAFD in 1992. The AAFD is a national non-profit trade association representing the rights and interests of franchisees and independent dealers throughout the United States with the stated purpose of "Employing marketplace solutions to define, identify and promote Total Quality Franchising." With input from the AAFD we continue answering the question, "What do franchisees really want?" Proven Operating System Franchisees like to know what they are getting for their franchise and on-going royalty fees. They expect a proven and uniform operating system and do not want to be the system “guinea pig”. Franchisees want a system that has been tested and refined and that will allow them to generate a fair return on their investment. Consequently, it is the franchisor’s responsibility for developing, maintaining, protecting, policing and enforcing the trademarks, copyrights, patents, trade dress, and confidential information associated with the franchise system for the benefit of the franchise system. Franchisees expect equal enforcement of system standards. In most franchise systems, uniformity of products and service are achieved when everyone is following the system. Collaborative Approach Best for System Changes Ever-changing market conditions may require adjustments to the franchise system to keep it current and competitive. Any proposed changes or improvements to the system should be tested in company units or designated test units before rollout. In many franchise systems, franchisees are actively involved in the day-to-day operation and often have a unique understanding of the current and future market conditions. These franchisees should play a key role in making any system changes. Franchisees expect improvements to the system that will grow their business. Ongoing research and development by the franchisor in cooperation with the franchise network is a good way to accomplish this. Franchisees want to have input into system changes that they will pay for eventually. Franchise agreements typically require the franchisee to upgrade their operation upon renewal or at predetermined intervals. Problems occur when the upgrades are not thoroughly tested, appear frivolous, and/or provide an excessive economic burden that cannot be easily absorbed by the budgeted cash flow of the business. The Power of Many, the Strength as One The purchasing power of the franchise system is an important reason to venture into franchising instead of starting an independent business. The role of the franchisor is to set the purchasing standards and negotiate the best prices and vendor allowances and rebates so the savings can benefit the entire system. There is a critical caution here: franchise system purchasing programs can literally define a quality franchise system or can be abused to take undue advantage of the franchisee as a captive customer for the franchisor’s sole benefit. The franchisor designates the approved vendors for any products or services and is entitled to a reasonable profit on the sale of such products. Price fixing and collusion are examples of franchise group buying gone astray. Franchisees expect a competitive price that enables them to achieve a reasonable profit margin. Problems arise in franchise systems that attempt to use purchasing practices as a profit center. Abuses occur when franchisors exact commissions, rebates and other benefits from suppliers at the expense of the franchisees in the network. THE AMERICAN ASSOCIATION OF FRANCHISEES AND DEALERS HAS DEVELOPED THE FRANCHISEE BILL OF RIGHTS AND WORKS TO PROMOTE AWARENESS AND ACCEPTANCE OF IT AMONG THE FRANCHISING COMMUNITY AND THE GENERAL PUBLIC. Franchisee Bill of Rights as the minimum requirements of a fair and equitable franchise system: • The right to an equity in the franchised business. • The right to engage in a trade or business, including the right to a post-termination right to compete. • The right to the franchisors loyalty, good faith and fair dealing, and due care in the performance of the franchisors duties, and a fiduciary relationship where one has been promised or created by conduct. • The right to trademark protection. • The right to full disclosure from the franchisor, including the right to earnings data available to the franchisor which is relevant to the franchisees decision to enter or remain in the franchise relationship. • The right to initial and ongoing training and support. • The right to competitive sourcing of inventory, product, service and supplies. • The right to reasonable restraints upon the franchisors ability to require changes within the franchise system. • The right to marketing assistance. • The right to associate with other franchisees. • The right to representation and access to the franchisor. • The right to local dispute resolution and protection under the laws and the courts of the franchisees jurisdiction. • A reasonable right to renew the franchise. • The reciprocal right to terminate the franchise agreement for reasonable and just cause, and the right not to face termination, unless for cause A crucial hurdle in franchising is finding a winning location. In most retail franchise systems, the location of a unit is of critical importance to the success of the business. Franchisees expect reasonable guidance with site selection. At the very least, the site should have the approval of the franchisor based on research and experience, and not a mere “gut feeling.” Mature franchise systems with the muscle and prowess to command better locations can solve the real estate puzzle. Emerging new systems struggle with the site selection criteria and may not have the clout to command “A” locations. Central to much franchise litigation are radius restrictions and other franchise real estate issues. The last thing franchisees want is to share their prospective revenues with encroaching units from within their franchise system. To limit territorial disputes within the system, Purvin believes that, "Most quality systems provide realistic market protections, which can include a defined territory, a protected mileage radius around the location, or a limit on the number of units to be opened within a defined market or population. At the same time, a franchisor must adequately saturate a market to benefit the system and consumers while minimizing cannibalizing sales." Purvin cautions that, "Often mature franchise companies present greater encroachment issues because they tend to have successfully saturated their markets." Notwithstanding the fact that mature companies may meet the criteria of being proven and established, they should be more cautious with expansion. Companies like Meineke, Burger King and KFC have established exemplary programs to protect against encroachment, according to Purvin. Fair and Equitable Franchise Agreement Many franchisees would argue that a “fair and equitable franchise agreement” is an oxymoron! After all—the franchise agreement is drafted by attorneys representing the franchisor for the benefit of the franchisor. Franchise agreements must have some mutual benefit or no one would sign the documents. The new wave inching its way into franchising is the collectively bargained franchise agreement, the product of negotiations between franchisors and their independent franchisee associations. The purpose of this negotiated document is to have a more balanced agreement than the previous “take it or leave it” franchise document. Purvin and the AAFD are dedicated to promoting negotiated franchisee agreements that recognize the legitimate needs of both franchisors and franchisees. For example, franchisees expect the initial term of the franchise agreement to be of sufficient length for a franchisee to reasonably amortize the initial investment to achieve an adequate and fair return on investment. Franchisees also want to be treated fairly on renewal of the franchise agreement. ”The AAFD is dedicated to negotiated franchise relationships as the primary method of reform within the franchise community,” said Purvin. “Our effort has been to define the parameters of fair and balanced agreements, and to identify and reward franchise systems that have adopted exemplary practices and relationships.” The AAFD’s Fair Franchising Standards Committee has adopted and published more than 130 standards of recommended practices affecting every aspect of the typical franchise relationship. The AAFD Standards are themselves the product of “collective bargaining” as the Committee is made up of franchisors, franchisees and franchise attorneys who must reach consensus on how franchisors and franchisees should treat each other. Franchisee Associations—Critical for Balanced Dialogue A franchisor should recognize and avoid interference with a franchisee's right to freely associate and participate in an independent franchisee association. New franchisors should realize that franchisees will want to organize and voice their opinion. The enlightened franchisors will establish the terms and conditions of the franchisee organization that will benefit the system and the franchisor. Added Purvin, “Enlightened franchisees will form associations focused on being productive citizens within the franchise community—intent on solving both the problems of the franchisor as well as the members of the Association. The AAFD calls the win-win approach Total Quality Franchising.” Franchisees who try to associate in groups should not be subject to retaliatory action. A franchisor should act in good faith in its dealings with an independent franchisee association. “Given the disparity in bargaining power inherent in the franchise relationship, group association is a primary method by which franchisee’s can effectively voice their concerns to their franchisor,” states Purvin. Both the franchisor and the franchisees of a franchise system should have the right to air grievances on all issues (on both an individual and group basis) without suffering negative repercussions. The system should adopt a jointly endorsed grievance procedure. Building Brand Recognition The last step towards a successful / symbiotic relationship in franchising is being able to build brand recognition. There has to be a recognizable image for the franchise to distinguish its brand from others in the market place. Building the brand through marketing is critical for the franchise partnership. The franchisor must develop an effective marketing position and advertising strategy to increase brand awareness and maximize system sales. The franchisee must execute the strategy at the local and store level. Most franchise systems require advertising fund contributions to support building the brand. All monies in the advertising fund should be treated as trust funds and must be segregated and kept in a separate account from monies of a franchisor. A franchisor has the right to promote its system and the marks in order to protect the integrity of the marks. This needs to be balanced against a franchisee's need to have a voice in the type and content of advertising conducted. When a franchisee is required to advertise in its local market, a franchisee should have some input into the advertising strategies and expenditures with a franchisor's guidance and approval. The franchise relationship is often referred to as the franchise partnership. Both partners work together for the mutual benefit but each has independent and maybe even conflicting goals. As long as both understand and appreciate these goals, there can be a harmonious franchise system.